Chapter 4.1 – What is demand?

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  • Demand – combination of desire, ability and willingness to buy a product
  • Microeconomics – part of economics that studies small units, such as individuals and firms

An introduction to Demand

  • Market economy – economic system in which people and firms make all economic decisions
  • Demand schedule – a table that lists how much of a product consumers will buy at all possible prices
  • Demand has two variables: price and quantity
  • Demand curve – a curve that shows the quantities demanded at all possible prices

The law of demand

  • Law of demand – rule stating that consumers will buy more of a product at lower prices and less at higher prices (inverse relationship)
  • Market demand curve – a curve that shows how much of a product all consumers will buy at all possible prices

Demand and marginal utility

  • Marginal utility – additional satisfaction or usefulness a consumer gets from having one more unit of a product
  • Utility – the pleasure, satisfaction, or benefit a person receives from consuming a product
  • Diminishing marginal utility – decrease in satisfaction or usefulness from having one more unit of the same product

Chapter 4.2 – factors affecting demand

Change in the quantity

  • Change in quantity demanded – movement along the demand curve showing that the amount someone is willing to purchase changes when the price changes
  • Income effect – that part of a change in quantity demanded due to a change in the buyer’s real income when a price changes
  • Substitution effect – that part of a change in quantity demanded due to a price change that makes other products more or less costly

 

Change in demand

  • Change in demand – shift of the demand curve when people buy different amounts at every price
  • Changes in consumer income can cause a change in demand
    • Normal goods – direct relationship
    • Inferior goods – inverse relationship
  • Change in consumer tastes and preferences can cause a change in demand (direct)
  • Substitutes – competing products that can be used in place of one another (direct)
  • Complements – products that increase the use of other products (inverse)
  • The way people think about the future can affect demand
  • The market demand curve can also change if there is a change in the number of consumers (direct relationship)

Chapter 4.3 –  elasticity of demand

  • Elasticity – a measure of responsiveness that shows how one variable responds to a change in another variable
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Demand elasticity

  • Demand elasticity – a measure that shows how a change in quantity demanded responds to a change in price, determined by time, substitutes, income
  • Elastic – type of elasticity where a change in price causes a relatively larger change in quantity demanded
  • Inelastic – type of elasticity where a change in price causes a relatively smaller change in quantity demanded
  • Unit elastic – type of elasticity where a change in price causes a proportional change in quantity demanded
Type of demandElasticInelasticUnit elastic
Change in priceDownDownDown
Change in expenditureUpDownNo change

 

The total expenditures test

  • Total expenditures = price (quantity demanded)
  • If a business can determine a new product’s demand elasticity, it can find the price that will maximize total revenues

Determinants of demand elasticity (if yes: elastic, if no: inelastic)

  • Can purchase be delayed?
  • Are adequate substitutes available?
  • Does purchase use a large portion of income?

Chapter 5.1 – what is supply?

  • Supply – amount of a product offered for sale at all possible prices
  • Law of supply – principle that more will be offered for sale at higher prices than at lower prices

An introduction to supply

  • Supply schedule – a table showing how much a producer will supply at all possible prices
  • Supply curve – a graph that shows the different amounts of a product supplied over a range of possible prices
  • Market supply – a graph that shows the various amounts offered by all firms over a range of possible prices
  • Quantity supplied – amount offered for sale at a given price
  • Change in quantity supplied – change in amount offered for sale when the price changes

Change in supply

  • Change in supply – situation where different amounts are offered for sale at all possible prices in the market; shift of the supply curve (direct relationship)
  • A change in the cost of productive inputs such as land, labor, and capital can cause a change in supply
  • Increase productivity, more output is produced at every price, which shifts the supply curve to the right
  • New technology tends to shift the supply curve to the right.
  • Taxes increase causes the supply curve to shift to the left
  • Expectations about the future price of the product can also affect supply
  • When the government establishes new regulations, the cost of production can change, causing a change in supply
  • A change in the number of suppliers can cause the market supply curve to shift to the right or left
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Elasticity of supply

  • Supply elasticity – a measure of how the quantity supplied responds to a change in price
    • Are resource inputs readily available?
    • Are factors mobile – are workers prepared to move to where they are needed?
    • Can finished products be easily stored, and are they existing stocks?
    • How long and complex is the production cycle or production process?
    • Time is the sole significant determinant of price elasticity of supply
  • The three elasticities
Type of elasticityChange in quantity supplied due to a change in price
ElasticMore than proportional
Unit elasticProportional
InelasticLess than proportional

Chapter 6.1 – prices as signals

  • Price – monetary value of a product as established by supply and demand
  • High prices signal buyers to buy less and producers to produce more, vice versa

Advantages of Prices

  • Prices are neutral, they favor neither the producer nor the consumer
  • Flexible
  • Most people have known about prices all their lives
  • Prices have no cost of administration

Prices as a system

  • Not only help individuals make decisions; they also serve as signals that help allocate resources between markets
  • Rebate – partial refund of a product’s original price
  • Alternative to the price system – rationing – used in command like economy (problems below)
    • Equity/fairness
    • Administrative cost
    • No incentives
    • Inefficient/opaque

The price adjustment process

  • Market economy are voluntary, compromise settles differences between buyers and sellers
  • Economic model – a simplified version of a complex behavior expressed in the form of an equation, graph, or illustration
  • Equilibrium price – price where quantity supplied equals quantity demanded
  • Surplus – situation where quantity supplied is greater than quantity demanded at a given price
  • Shortage – situation where quantity supplied is less than quantity demanded at a given price

Explaining and predicting prices

  • Change in supply and or demand may occur based on situations
  • These changes affect price
  • Whenever supply or demand for a product fluctuates, the elasticity of the two curves affects the size of the price change

When markets talk

  • Markets send signals in that they speak collectively for all the buyers and sellers who trade in the market
  • Talk when prices move up or down significantly in reaction to events that take place elsewhere in the economy

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